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Who Gains and Who Loses as the Dollar Falls?

There seems to be growing concern about the dollar's recent
weakness - some might even call it hysteria. Yes, the dollar has
weakened this year, but the losses have been relatively modest in
most cases, with the exceptions being the Australian dollar (AUD),
Brazilian real (BRL) and a couple of others. The euro (EUR) is at
the same level it was at in August 2008, as is the overall dollar
index (DXY). So why all the fuss?

So far, most of the chatter has been in the financial press and is
an academic discussion about whether this will remain an orderly
decline or will turn into a collapse and what the consequences will
be. We have only heard occasional murmurs of concern from those
that stand the most to lose. I believe they include most countries,
with the exception of the U.S. and those countries in Asia that
have their currencies pegged to the dollar - obviously, China is
the most visible example.

We stand to gain for obvious reasons. A weak dollar is an export
boost and a disincentive for our consumers to buy imported goods.
It could help us tremendously in reducing our trade deficit,
thereby boosting GDP. The main concern we would have under normal
circumstances would be heightened inflation risk, as imported goods
cost more and dollar weakness is the equivalent of monetary easing.
However, that is not a concern today, and while it may be in the
future, that is many moons away - almost certainly after the
congressional elections next year.

China stands to gain in several ways. They have essentially pegged
the renminbi at around 6.83 since last July, and as a result, the
currency has depreciated versus most other currencies as the dollar
has fallen. That is a huge boost to China's export competitiveness
(not that they need it) and even more importantly, a significant
reason why their economy has bounced back as rapidly as it has.
China's day of reckoning with inflation will approach far faster
than it will for us, but for now they have enjoyed the upside
without facing any significant consequences. Until they have
reduced their holdings of U.S. assets or hedged most of the
currency risk, allowing their currency to appreciate versus the
dollar would imply large markdowns in the value of those assets -
yet another reason why this unofficial peg will last a while
longer. Of course, a weaker renminbi implies soaring import costs
as commodity and other raw material prices soar, which is why the
Chinese have recently entered into several bilateral barter
agreements, which immunize them to an extent.

For the rest of the world, the weak dollar is a tax on exports to
the U.S., while enhancing our export competitiveness. However, I
believe that the European Union in particular is far more concerned
with the benefits accruing to China in this regard than they are
with us. China's share of European trade (both exports and imports)
is growing far faster than their trade with us and China already
has a currency that is dramatically undervalued, even without the
help of the dollar link. The one benefit they get is that the price
of oil, gold or other commodities is more stable in euros than it
is in dollars, but overall, the negatives far outweigh the
positives. This drag on trade is far more an issue for the slower
growing economies of Western Europe that desperately need a boost
than it is for commodity producers such as Australia and Canada, or
faster growing emerging market countries like Brazil.

As a result, I expect more vocal protests from Europe should the
dollar decline continue, and especially, if the pace should
intensify. We will respond with the usual statements about
following a strong dollar policy and as usual, it will count for
absolutely nothing, unless the dollar nosedives. That could
destabilize other financial markets and the Fed and Treasury would
respond. I consider that highly unlikely.

China will remain silent on the issue and will in all likelihood
stick to their agenda. In my opinion, they will keep the renminbi
stable until unemployment has fallen, GDP growth is back at a nine
to ten percent level, inflation is a more pressing issue and their
exposure to the USD is more manageable. That implies no significant
change until late 2010 or beyond. Without China's active
cooperation, the chances of an accelerated dollar sell-off are
remote - there is no imminent catalyst, no other capital market is
able to absorb the supply, and fundamentally, the dollar is now
under-valued vs. most currencies, the notable exceptions being the
CNY and other regional Asian currencies.

However, the world is rapidly being aligned into three major
trading blocs: the U.S., Europe and Asia. As Asia's economies grow
and their share of global GDP increases - as it surely will - they
will want more control over their monetary policy. At present, they
effectively get their cues from the Federal Reserve, given the
inflexibility of their currencies. When they decide the time is
right, Asian currencies will delink from the dollar. This will
almost certainly reduce the dollar's reserve currency status, but
is not necessarily a bad thing, nor is it likely to play out in a
catastrophic fashion. It will almost certainly result in Asian
currencies collectively appreciating vs. the dollar and the rest of
the world. I believe that will take years, not decades to play out.
In the interim, Europe will keep protesting, we will continue our
policy of benign neglect and China will reap the gains.

There seems to be growing concern about the dollar's recentweakness - some might even call it hysteria. Yes, the dollar hasweakened this year, but the losses have been relatively modest inmost cases, with the exceptions being the Australian dollar (AUD),Brazilian real (BRL) and a couple of others. The euro (EUR) is atthe same level it was at in August 2008, as is the overall dollarindex (DXY). So why all the fuss?

So far, most of the chatter has been in the financial press and isan academic discussion about whether this will remain an orderlydecline or will turn into a collapse and what the consequences willbe. We have only heard occasional murmurs of concern from thosethat stand the most to lose. I believe they include most countries,with the exception of the U.S. and those countries in Asia thathave their currencies pegged to the dollar - obviously, China isthe most visible example.

We stand to gain for obvious reasons. A weak dollar is an exportboost and a disincentive for our consumers to buy imported goods.It could help us tremendously in reducing our trade deficit,thereby boosting GDP. The main concern we would have under normalcircumstances would be heightened inflation risk, as imported goodscost more and dollar weakness is the equivalent of monetary easing.However, that is not a concern today, and while it may be in thefuture, that is many moons away - almost certainly after thecongressional elections next year.

China stands to gain in several ways. They have essentially peggedthe renminbi at around 6.83 since last July, and as a result, thecurrency has depreciated versus most other currencies as the dollarhas fallen. That is a huge boost to China's export competitiveness(not that they need it) and even more importantly, a significantreason why their economy has bounced back as rapidly as it has.China's day of reckoning with inflation will approach far fasterthan it will for us, but for now they have enjoyed the upsidewithout facing any significant consequences. Until they havereduced their holdings of U.S. assets or hedged...Read More

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